CFO Roundtable 2024: Preparation, Perspective, Diligence

Q: Now that CECL adoption is complete, examiners have begun to focus attention on the qualitative factors that banks use when providing the allowance for their various applicable loan portfolios. How do you expect your use of qualitative factors in reserve management will change as economic conditions change and regulators adopt a more granular approach when the risk of credit loss increases?

Anita Drentlaw: We began using qualitative factors several years prior to CECL and have tried to take some of these qualitative factors and make them a bit more “objective” by measuring certain things in the portfolio—such as concentrations, collateral value, weighted risk ratings and portfolio volume changes—which then make them more consistent from quarter to quarter. Documenting the reasoning behind why you are deciding on those factors, which are fully subjective, is important, since examiners want to understand the reasoning behind why we have decided to use a factor of 0.5% compared to 1% or something else. I believe they will want us to use higher qualitative factors as credit and economic conditions become more challenging, and I think if we have been consistent in the past with moving them up and down accordingly—and documenting them appropriately—we should be able to have agreement with our examiners on our calculation.

Mike Gargaro: We just went through an FDIC exam in December 2023, and examiners told us they’ve seen a lot of different [CECL] models. So, it’s going to take a little bit of time, I’m guessing, for them to understand all the different nuances within each model. We have 10 different qualitative questions that we answer each quarter, and we’re still tweaking some of the other factors—more so than the qualitative ones—just to maintain our level of comfort with our reserve. I think most community banks [I’ve talked with], with their conservative nature, found that their CECL calculation was a third to half of what their current allowance calculation was.

“CFOs have their fingers on the pulse of the economy because they are trying to manage all these other kinds of risk that need decisions to be made regarding liquidity and duration management.”

—Anita Drentlaw, New Market Bank

Q: How have you thought about interest rate duration risk in the past year, and how such risk has generally affected your decision-making about financial accounting and regulatory capital management?

Gargaro: Rates are going to go up; they are going to go down. So, we obviously try to manage this with respect to our margin. Our loan and investment portfolio are both fairly diverse. We don’t lend to large, leased buildings with a bunch of office space and typically don’t lend to large downtown areas. We’re not in those kinds of markets to have to worry about that kind of product. On average, we are able to re-price about 25% to 30% of our loan yields annually. So, there’s good and bad with that.

Drentlaw: Unfortunately, almost all community banks have experienced increased duration risk as part of our investment portfolios, since rates went up so rapidly. The asset liability committee is having a lot more discussions about duration risk and the maximum amount of time we are willing to take on in terms of maturities, as well as the type of investments we are willing to purchase that don’t have as much optionality risk.

Greg Niska: I agree it has been a challenge. On one hand, you wouldn’t mind extending the portfolio a bit to lock in these higher yields for longer. On the other hand, you want to hold onto the liquidity to fund loan demand and cash in on the high yields in overnight funds. It’s been a balancing act between short-term needs and long-term strategies.

Q: As the CFO of your organization, you wear many hats, absorb much of the attention of the board, and can generally be identified unofficially as the key employee who pushes operational flow forward. How, if at all, has your role shifted of late?

Niska: I really haven’t noticed a change in terms of the overall expectations of the CFO role within the bank. Rather, the priorities have seemed to adjust with the overall regulatory landscape. For example, where I used to worry more about budget variances, I’m now focusing more time on interest rate risk. Further, where I used to worry more about how to deploy excess liquidity, we’re now focused on how to fund organic [loan] growth. I really don’t feel like any of this is new, just a shift in focus.

Louise Bonvechio: Besides the finance area, I also manage facilities, HR and IT. Since two [of these] areas represent the largest non-interest expense sections of the budget, I find it helpful to be intimately involved [across all] these areas. It provides the opportunity to be at the table for key discussions and decision-making as we grow the bank. It keeps us aligned strategically as we make decisions in each area, and having strong leadership in each of these areas has resulted in satisfactory audits and exams.

Drentlaw: I agree that the CFO position seems to have more and more pressure and responsibility, especially in terms of asset-liability management. I also think that regulatory agency personnel are starting to expect all banks to have a specific person for CFO/finance duties. But in community banks, especially smaller ones, that is a tall order. I think we are going to need to be innovative by using as much technology as possible to assist us, along with utilizing our peer CFOs to share ideas and try to help with efficiencies and being effective.

“Most organizations have to make tough decisions here and there, depending on the credit or loan customer and what they’re looking to do.”

—Mike Gargaro, Citizens First Bank

Q: What role should the CFO play in keeping the management team, board of directors and finance team focused on ensuring that the bank is ready to quickly identify and address credit quality concerns as they arise, even when the bank is so far removed from its last major credit concern event?

Bonvechio: As the CFO, I have a lead role in the ACL [allowances for credit losses] calculation and decisions around adjustments of the qualitative score card. These decisions are well-documented; I regularly report to management and the board on how these indicators are trending and what adjustments I am recommending in the qualitative factors, as well as the impact it is having on the current-year provision and the ACL-to-loans coverage ratio. Having a seat at the table for loan policy review to know that as an organization we are not making changes to our credit standards that could result in lower credit quality over time is important. I also find it helpful to be a member of the loan committee to hear firsthand how credit decisions are being made, keeping an eye on exceptions to loan policy, particularly the use of personal guarantees and debt service coverage ratios.

Drentlaw: CFOs have their fingers on the pulse of the economy because they are trying to manage all these other kinds of risk that need decisions to be made regarding liquidity and duration management. Sharing information learned through various news sources, webinars, conferences and other areas is a way CFOs can play a role in being proactive in helping to manage credit quality. I also think assisting with stress testing practices—whether that is helping to develop how to stress test individual credits or the portfolio as a whole—can help to identify credit changes more quickly. Additionally, being the position that most likely calculates the CECL model gives the CFO a chance to see major changes or shifts in the portfolio. Since this calculation isn’t an exact science, it can give the CFO the opportunity to make sure the bank is reserved adequately to be able to withstand an increased credit concern event.

“Just because you don’t hit records each and every year doesn’t point to impending doom.”

—Greg Niska, Gateway Commercial Bank

Q: What impact has this current difficult rate environment had on your ability to provide solutions to answer the challenge of earnings growth?

Niska: For the most part, I don’t think this year is going to be a “record” earnings year as rates stay higher and competition for deposits remains strong, fueling further margin pressure—hopefully slowing, from what we’ve seen. However, just because you don’t hit records each and every year doesn’t point to impending doom, and with balance sheet growth normalizing, it’s putting less pressure on capital levels, which at least for us, remain strong.

Gargaro: [The majority of our] lenders have never seen a rate rise in their career here at the bank. They’re used to a low, flat yield curve, which it was for many years prior to this recent steep rate increase. It’s about managing your margin. Most organizations have to make tough decisions here and there, depending on the credit or loan customer and what they’re looking to do. We’re also looking at our other non-interest income streams. On the non-interest expense side, we’re looking for areas we can improve upon to help maintain our net income. And I do think we’re starting to get to the bottom of where we think margin may settle.

Drentlaw: The higher rate environment definitely has affected our cost of funds, which increases our interest expense as well as suppresses credit and mortgage demand, since businesses and consumers don’t want to take on higher interest rates, resulting in additional interest expense. That, along with inflation causing higher prices on everything from technology, annual maintenance fees and utilities, along with increased wage pressure, is challenging earnings growth. New technology, which may have a potential for eventually increasing earnings by providing a new service, is also expensive, which makes it difficult to make the decision to implement. Producing more income in our regulatory environment is a harder problem to solve.

Q: What role does the CFO play in understanding the importance of technological advancement and any threats that others may miss?

Gargaro: I’ve been heavily involved in the technology side of the bank since I’ve been here, which is a little over two and a half years. In my previous job, I was heavily involved in it as well. The CFO does play a role, but you also have to have buy-in from the rest of the staff, management and the board. [Community banks are] not like a big bank where we have unlimited technology budget and a bunch of folks developing software on staff. We’re at the mercy of technology vendors themselves and what they’re offering and providing.

Drentlaw: The CFO at our bank also plays a large role in understanding technology and additional threats that come with it. Both sides of the coin need to be evaluated and the decision weighed to see if the new technology is worth it. I think the largest change has been the increasingly rapid introduction of new technology and the amount of cyber risk that comes with it. Much more time has to be spent in this area than ever before.

Bonvechio: I am not an expert in IT, so it is truly important to have an IT manager who is highly knowledgeable and committed to keeping up with the latest technology but is also highly vigilant in keeping our systems safe and appropriate for our franchise. This is especially true when it comes to AI. We need to recognize when the use of AI is appropriate and when it could be introducing influences that are inconsistent with our risk appetite. We don’t want to be left behind, but we also don’t want AI to take us to places with unintended consequences.

Niska: While certainly the CFO role is an important part in risk management, I truly feel it is incumbent upon the whole team to stay educated and vigilant in their individual day-to-day roles, especially as [emerging technology, such as AI], becomes more widespread. Risks associated with technology aren’t just the responsibility of any one position in the bank anymore, because risks have evolved to be much more complex.